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Morningstar | Despite Soft U.S. Results, Abbott Saw Strong Performance in International Markets in 2Q

Although Abbott posted strong second-quarter results that ran slightly ahead of our expectations, we’re retaining our fair value estimate, as our adjustments did not materially shift our valuation. Robust top-line growth in international markets more than offset anemic sales in the U.S. that were hampered by the timing of new product launches. On the bottom line, Abbott largely met our expectations. With the first half of 2018 over, we see little to change our thinking on Abbott’s narrow economic moat.

We’re particularly pleased to see the pediatric nutritional segment return to growth in the international markets--up 8% organically, and further aided by foreign exchange tailwinds. Just as we had seen this segment weighed down by regulatory changes in China, the strong second-quarter growth was driven by China, where the dust finally settled in late 2017. We think Abbott should now reap the rewards of being a larger competitor that can navigate the more rigorous regulation that has resulted in a smaller pool of rivals.

The U.S. launch of Libre Freestyle Flash continuous glucose monitor has gotten off to a strong start and could exceed our projection for 35% growth this year. We continue to think the user-friendliness of this product and its relatively low price should help increase the penetration of CGM use in the Type 2 Diabetes patient pool, which has largely stuck with blood glucose meters for decades. We think Abbott’s growing presence in the Type 2 segment will make it harder for rival Dexcom to make inroads there.

The main area of weakness were cardiac-related--vascular and rhythm management were down 5% and 4% in the U.S., respectively. We’re less concerned about vascular because Abbott’s next-gen coronary stent Xience Sierra was recently approved and adoption of the product should reverse the recent declines in the coming quarters. There’s nothing that would lead us to believe the typical back-and-forth in trading market share that comes with the launch of a new product won’t hold this time around.

On the other hand, we think Abbott could see competitive pressure mute its cardiac rhythm management segment for some time. Despite the recent launches of MRI-compatible pacemakers and implantable cardioverter defibrillators, Abbott’s worldwide CRM business saw sales decline 4% organically in the second quarter. While management chalked this up to accelerated battery replacements in 2017, we think Medtronic’s novel risk-based contracting with its Tyrx antibacterial envelope for pacemakers and ICDs is likely also a factor. Medtronic has roughly 20% of U.S. hospitals under contract to use its CRM systems along with its Tyrx envelope, which significantly reduces the probability of infection that, on average, costs the hospital $10,000 per patient. By aligning practitioner concerns about patient outcomes with hospitals' concerns about the cost of complications, Medtronic can offer a compelling proposition for hospitals, from our perspective. We expect Medtronic will continue to sign on more hospitals to this kind of risk-based contract, which will also shield the firm from the brunt of competitive new product cycles in CRM.